Bespoke portfolio
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A bespoke portfolio is a list of reference securities in a Synthetic CDO that has been arranged by an investment bank and selected by or specifically for a particular investor.[1]
The list of reference securities making up a portfolio is one of the primary drivers of the investment outcome of a synthetic CDO [2] Because the portfolio is not that of an index like the CDX or iTraxx, the mean default probabilities of the reference securities, their distribution of default probabilities, their default correlations and the recovery rates upon default can vary greatly.
In principle, the investor chooses the credits and decides on the attachment and detachment points.[3] In reality, the arranger has a good deal of input when it comes to credit selection. Most arrangers manage their risks by selling protection on single-name CDS or on the CDX indexes and they have little interest in illiquid names that do not trade in the market.
Synthetic CDOs with bespoke portfolios can have very different default correlation characteristics from credit indices with similar distributions of riskiness. This is because bespoke portfolios can include reference securities that are highly correlated, either because they are issued by different subsidiaries of the same parent company, because they can include closely related but separate companies, or because the bespoke portfolios can include much higher concentrations in single industries than occurs in indices.[4] Determining the fair default correlation for a bespoke portfolio can be very difficult. The chart on the right shows that differences in correlation can greatly change the probability distribution of defaults and this change the fair value of any given CDO tranche.
Initially, most bespoke CDOs were static, meaning that the list of reference securities would change only because of default, because of a succession event, or because of the disappearance of a reference security or its issuer. Managed bespoke portfolios are those where a third party investment manager is appointed to select the bespoke portfolio but also to trade in and out of the underlying reference securities to exploit trading opportunities or avoid credit downgrades.
A bespoke portfolio CDO can be structured as a swap between an investor and an arranger, in which case the investor does not need to fund the purchase of the synthetic CDO notes. The majority of bespoke portfolio CDOs, however, are embedded into credit-linked notes and purchased by the investor.[2]
References[edit]
- ↑ Structured Credit Insights: Instruments, Valuation and Strategies. Morgan Stanley, April 2006, Second Edition
- ↑ 2.0 2.1 Structured Products and Related Credit Derivatives - A Comprehensive Guide for Investors. pp254-255. Lancaster Schultz Fabozzi. John Wiley & Sons, Inc., 2008
- ↑ Merrill Lynch Credit Derivatives Handbook 2006 - Volume 2, page 4. Merrill Lynch, 14 February 2006
- ↑ Merrill Lynch Credit Derivatives Handbook 2006 - Volume 2, page 14. Merrill Lynch, 14 February 2006
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